India now has a once-in-a-lifetime opportunity to significantly increase the flow of global long-term capital by extending the LTCG tax exemption to investments by all regulated global alternative investment funds (PE/VC) in desired sectors—a potential LTCG tax only arises in the future at the time of exit from an investment in India by a long-term investor.
When it comes to fiscal stimulus, the pandemic-struck world feels like a déjà vu (by a huge multiple) of the 2008 financial markets implosion when it comes to cheap money raining from the treasury chests of the rich governments of the US, the UK, Europe and Japan. While most of these measures are aimed at immediately reviving business activities in the respective markets, the reality of financial markets dictates that a certain proportion of this surfeit of cash would be deployed in investment avenues outside the domestic markets. It seems fair to presume that, besides a rethink on supply-chain dependencies by manufacturing MNCs, global institutional and alternative investment funds too would look at diversification of their investments.
India has announced further opening up of sectors like insurance and defence as part of its economic revival package. In the 2019 Budget, a move to afford long-term capital gains (LTCG) tax exemption to sovereign wealth funds (SWFs) for investments in specified infrastructure projects in the next three years signalled India’s resolve to attract long-term and patient, institutional, global investment capital. India now has a once-in-a-lifetime opportunity to significantly increase the flow of global long-term capital by extending the LTCG tax exemption to investments by all regulated global alternative investment funds (PE/VC) in desired sectors—a potential LTCG tax only arises in the future at the time of exit from an investment in India by a long-term investor. However, at the time of making an investment, there is no question of taxation. Hence, there is no immediate loss of tax revenue to the exchequer. It must be noted that alternative investment funds are a major source of global capital ($1.5 trillion invested by PEs in 2019), with India’s share being in excess of $40 billion (EY research for India PE trend book 2020). Extending the LTCG tax exemption to these giant global investment institutions, with relatively patient and long-term investment philosophy, would result in significantly increased investments without current fiscal burden.
Another area is attracting fund managers of India-focused funds as well as global funds with a significant India allocation to set up shop in India. The AUM of FPIs in India is close to $400 billion (as per NSDL-FPI Monitor) and that of India-focused FPIs alone is estimated to be $40 billion (EY research). Traditionally, fund management companies of even 100% India-focused funds have typically preferred to be located in jurisdictions like Mauritius and Singapore. Fear of subjecting the overseas fund toa more adverse/uncertain Indian taxation by virtue of having the fund management company located in India and being exposed to the risk of business presence/deemed residency in India is one reason. During the previous Narendra Modi regime, efforts were made to introduce a mechanism whereby tax certainty was to be provided against such tax impact even if the fund management company were to be located in India. However, due to a long list of conditions to be fulfilled, many of which are practically untenable, there have been a only a handful of proposals for locating fund management operations in India. There is an urgent need to effect desirable changes, like dismantling of most of these debilitating conditions (for example, maximum cap of 26% ownership in Indian companies and proving there is no indirect ownership of even a minority share by Indian residents in the overseas fund). Most of these conditions are not the norm in global fund management jurisdictions like Mauritius and Singapore, which compete effectively with India for such operations. Removing these irritants won’t cause any adverse revenue impact for the Indian government.
To conclude, the stars in the global investment industry are aligned with India. By effecting smart changes in existing provisions on LTCG tax exemption for global investment funds and offering greater clarity and certainty with respect to taxation of such funds investing in Indian companies where fund management is done in India, it is possible to attract a far higher level of global long-term investment flows with minimum cost to the exchequer.
The author is national tax leader, EY India. Views are personal